What the ... ? Why did my paycheck shrink?

By NEIL IRWIN The Washington Post

Washington - Many Americans just received their first paycheck of 2013. That sound you hear is the collective "What the ...?" they have emitted upon looking at their pay stub.

For all the self-congratulatory back-patting from the White House and Congress on the deal that averted the "fiscal cliff" of tax increases - the deal locked in the George W. Bush-era tax cuts for households making under $450,000 - they tended not to mention what the deal did, or rather didn't do, on the payroll tax. A 2 percentage point reduction in the Social Security tax, which hits all American workers, had been enacted at the end of 2010. In the fiscal cliff deal, Congress and President Obama neither extended it further nor agreed on any other policies that might have the similar effect of leaving more money in workers' pockets.

The numbers, for anybody who hasn't checked their paycheck yet (or won't get paid in 2013 until later in the month):

For someone who makes the U.S. average for private sector workers of $818.69 a week and is paid every other week, that adds up to a reduction of $32.75 in each paycheck. For higher earners, anyone making over $113,700 annually, each bi-weekly paycheck will decline by $87.46.

The increase in payroll taxes has gone from being an abstraction in Washington policy debates that politicians prefer not to talk about to being something very real.

The big question for the economy as 2013 gets underway is how America will react to their smaller paychecks. It is uncharted waters in many way: For most of the last two decades, taxes have been steadily falling. There is not much evidence for just how much Americans will pare back in response to tighter times and a higher tax burden.

One place to look for evidence is what happened when the payroll tax cut was implemented at the start of 2011. In the first six months of the year, personal consumption spending rose 2.2 percent, though that coincided with a spike in fuel prices tied to unrest in the Middle East, so when adjusted for inflation consumption spending rose only 0.6 percent. (In a way, it turned out to be lucky timing; in effect, the payroll tax break offset the economic drag that came from what turned out to be a temporary bump in oil prices.)

But the open question for the economy in 2013 is whether Americans adjust differently when their paychecks have a tax-induced decline than they did when they received a bump.

In terms of consumer psychology, behavioral economists speak of "loss aversion," a tendency of people to be much more bummed out when they think they have lost something that belonged to them than if they gain it. A child might be much more upset to have a cookie taken away from them than they are happy to be given a cookie.

It is possible that as Americans learn of their lower take-home pay - either from reading news accounts around the fiscal cliff deal last week, or from opening their first paycheck of the year - they will adjust their entire spending plans for the year, which could make January a rough month for retailers and the economy as a whole.

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